MAKE IT OR BREAK IT TIME FOR INDIA

Takeaway:The FY13 budget stands to create either a meaningful buying opportunity or intense selling pressure across Indian financial markets.

SUMMARY BULLETS:

India's FY14 budget is due to be released on FEB 28; this is arguably the most important fiscal policy catalyst in India since the introduction of the FY12 budget roughly two years ago.

If Finance Minister Palaniappan Chidambaram’s deficit-reduction plan is interpreted favorably by the market (i.e. they rely more on actual spending cuts rather than aggressive economic growth and revenue assumptions), then the recent weakness across Indian financial markets may end shortly, as some showing of fiscal sobriety would allow the RBI to resume its monetary easing activity – the #1 factor behind the recent upswings across India’s equity, currency and bond markets (as expected, the RBI cut rates on 1/29).

If the aforementioned measures are not deemed credible, then expect continued weakness across Indian financial markets – at least over the next few weeks. That would likely be driven by a measured reversal of international capital flows.

The SENSEX is down -3.8% since it’s JAN 25th cycle-peak and the INR is down -1.6% vs. the USD since its FEB 5th cycle-peak and both continue to correct in line with our expectations.

All eyes are on the FEB 28th introduction of the FY14 Budget where Finance Minister Palaniappan Chidambaram is expected to announce steps to reduce the budget deficit to 4.8% of GDP in the upcoming fiscal year ending in MAR ‘14 and to 3% by FY17.

If Chidambaram’s deficit-reduction plan is interpreted favorably by the market (i.e. they rely more on actual spending cuts rather than aggressive economic growth and revenue assumptions), then the aforementioned corrections may end shortly, as some showing of fiscal sobriety would allow the RBI to resume its monetary easing activity – the #1 factor behind the recent upswings across India’s equity, currency and bond markets (the RBI cut rates on 1/29):

SENSEX is still up +5.6% from its 11/16 cycle-trough;

The INR is still up +2.9% from its 11/26 cycle-trough; and

India’s 10Y nominal yield is still down -43bps from its 11/23 cycle-peak.

If the aforementioned measures are not deemed credible, then expect continued weakness across Indian financial markets – at least over the next few weeks. That would likely be driven by a measured reversal of international capital flows.

Our updated risk management levels on Indian equities are included in the chart below. Watch that TREND line carefully; a confirmed hold or breakdown will tell us all we need to know about what the FY14 budget portends for India's structural growth and inflation dynamics.

Stay tuned.

Darius Dale

Senior Analyst

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02/25/13 02:51 PM EST

#QUADRILL-YEN: WHO IS HARUHIKO KURODA?

Takeaway:A confirmation of Haruhiko Kuroda as the next BOJ governor is explicitly bearish for the Japanese yen over the intermediate-to-long term.

SUMMARY BULLETS:

Regarding the aforementioned question, we can’t be more explicit in stating that this is precisely the “dovish [political] puppet” we thought current BOJ Governor Masaaki Shirakawa would eventually be replaced by early in the chronicles of our ultra-bearish thesis on the Japanese yen. Under the assumption that he is the new face of BOJ leadership, Japanese monetary policy will get a lot more aggressive over the intermediate term, as Kuroda has been openly supportive of the LDP’s drive to achieve “+5% monetary math”.

For example, in 2002 he co-authored an op-ed piece calling for the aggressive pursuit of a +3% inflation target in Japan, as well as globally-coordinated Policies To Inflate. It should also be noted that he was formerly a career Japanese bureaucrat, entering the Ministry of Finance in 1967, eventually rising to succeed Eisuke Sakakibara as Vice Finance Minister for International Affairs (i.e. Japan’s top currency market official). It was from Sakakibara a.k.a. “Mr. Yen” himself that Kuroda learned the skills necessary to contend and ultimately record “victories” in today’s global Currency War.

From our interpretation of the legacy media coverage of this trade, it seems like there are a number of investors and Old Wall pundits who now think the down-yen trade has played itself out and that the balance of risks points to a sideways/stronger yen from here amid likely BOJ policy disappointments. Much to the contrary, and within the context of our structural bullish bias on the USD, we continue to think the long USD/JPY trade is still in the early innings. In fact, we continue to see the next “stop” as ¥100 per USD w/ upside risk to ¥125 per USD over the long-term TAIL. We remain the bears on the Japanese yen, with the JPY now down -17% vs. the USD from when outlined the first components of our bearish thesis back on 9/27.

It has been widely reported this weekend that the Abe government has selected Asian Development Bank head and former Finance Ministry official Haruhiko Kuroda as its candidate to replace Masaaki Shirakawa as the next governor of the BOJ when the latter’s term expires on MAR 19.

Additionally, Reuters also cited comments from Japanese academic Kikuo Iwata stating that he has been asked to be a deputy governor of the BOJ (he also noted that he would accept the nomination). There is also talks that senior BOJ official Hiroshi Nakaso will also be nominated for the other deputy governor position.

It should be duly noted that any news on the candidacy front still speculation, as Economics Minster Akira Amari stated he had not yet heard from Shinzo Abe regarding these choices – at least not yet. Finance Minister Taro Aso was, however, out this weekend suggesting that Kuroda, 68, would be the “correct choice” as the next head of the Bank of Japan.

Under the assumption that these are the likely new faces of BOJ leadership, Japanese monetary policy will get a lot more aggressive over the intermediate term. Each of the three candidates are said to be explicit doves and supportive of the LDP’s drive to achieve “+5% monetary math”.

THE MARKET AGREES

This morning, 5Y JGB yields hit another record low (0.123%) on speculation one of the BOJ’s first steps towards achieving the inflation target under the new regime would be to increase the duration of its sovereign debt purchases, as their current policy of buying debt maturing in less than three years is the functional equivalent of swapping cash for cash – it’s no wonder Shirakawa’s BOJ hasn’t been able to help Japan overcome deflation in an era of all-time highs in natural resource prices.

Five-year breakeven inflation rates also hit another all-time high this AM as well (1.26%), as a Kuroda-led BOJ would be particularly supportive of rising inflation expectations in Japan. As recently as FEB 11th, he was out suggesting that the BOJ has “really substantial room for monetary easing” and that “the global standard for achieving inflation targets was a two-year time horizon”.

IS THIS A DONE DEAL?

Early media speculation suggests the DPJ is expected to support Kuroda’s candidacy in the Upper House (meaning he’ll eventually secure the job officially), but we’re still skeptical in the lack of further evidence on this front. Even if the DPJ doesn’t support Kuroda and/or any of the other two perceived LDP candidates, that doesn’t necessarily mean their candidacy is void. It simply means that the LDP and NKP coalition (83 and 19 seats, respectively) will have to gain the support of smaller regional parties instead.

Eleven votes from Your Party – which has rhetorically aligned themselves with the LDP-NKP platform on this agenda – would put them at 113 seats, leaving them 9 seats shy of a decisive victory, but still well within reach because we think the smaller parties will be more inclined to associate themselves with the LDP’s drive to reflate the Japanese economy ahead of the JUL ’13 Upper House elections, rather than side with the DPJ, which was blown out in the DEC Lower House elections.

For example, in 2002 he co-authored an op-ed piece calling for the aggressive pursuit of a +3% inflation target in Japan, as well as globally-coordinated Policies To Inflate:

“The BoJ would have to adopt innovative, non-traditional anti-deflationary policies. These should include an explicit inflation target of 3 per cent to be achieved in stages - such as 1 per cent inflation within a year, and 2-3 per cent within the following two years. The BoJ clearly needs to provide more liquidity to the market and constantly increase base money through purchases of long-term government bonds and other financial instruments. A tripartite strategy for global reflation would bring major benefits to the world economy with minimum cost.”

-Haruhiko Kuroda, DEC ‘02

It should also be noted that he was formerly a career Japanese bureaucrat, entering the Ministry of Finance in 1967, eventually rising to succeed Eisuke Sakakibara as Vice Finance Minister for International Affairs (i.e. Japan’s top currency market official) in 1999. It was from Sakakibara a.k.a. “Mr. Yen” himself that Kuroda learned the skills necessary to contend and ultimately record “victories” in today’s global Currency War.

WHERE TO FROM HERE?

Make no mistake, it remains Japan’s “turn” to take center-stage in this drama, as per our relative analysis of G3 post-crisis monetary policy:

From our interpretation of the legacy media coverage of this trade, it seems like there are a number of investors and Old Wall pundits who now think the down-yen trade has played itself out and that the balance of risks points to a sideways/stronger yen from here amid likely BOJ policy disappointments.

Much to the contrary, and within the context of our structural bullish bias on the USD, we continue to think the long USD/JPY trade is still in the early innings. In fact, we continue to see the next “stop” as ¥100 per USD w/ upside risk to ¥125 per USD over the long-term TAIL. We remain the bears on the Japanese yen, with the JPY now down -17% vs. the USD from when outlined the first components of our bearish thesis back on 9/27.

Darius Dale

Senior Analyst

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02/25/13 02:06 PM EST

Are Stocks Destroying Gold?

Looking at a three-month chart of the S&P 500 (SPY) versus the SPDR Gold Trust ETF (GLD), we can see that the US stock market has outperformed gold quite a bit with gold declining -9.2% and the S&P 500 gaining +7.54% during the time period.

Hedgeye Statistics

VIDEO: Staying Bullish

Hedgeye CEO Keith McCullough appeared on CNBC this afternoon to discuss his bullish thesis on the stock market. It comes down to three simple themes: a strong dollar to help drive consumption, low volatility and a rotation out of gold and Treasuries and into equities.

Key Themes From CAGNY

Last week, Hedgeye Consumer Staples Sector Head Rob Campagnino attended the 2013 Consumer Analyst Group of NY (CAGNY) Conference. His Twitter feed (@HedgeyeStaples) was quite active with takeaways from the conference; here's his review:

Each year, 25-30 of the largest and most recognizable names in consumer staples – from cigarettes to eyeliner and from beer to hand sanitizer, attempts to lay out its objectives for the coming year for over 600 analysts and portfolio managers. We have been a regular attendee for many years now and we wanted to offer our views coming out of CAGNY 2013.

To be frank, we would characterize CAGNY 2013 as largely uneventful and in some cases downright boring – no preannouncements or big strategic announcements (HNZ supplied that the week before). We didn’t hear much that changed our thinking relative to how we came into the year or how we left Q1 earnings season. Briefly, the key themes running through the presentations were:

Innovation – it’s the cost of doing business in the “new normal”. Consumers will pay a premium for value, perceived or real. Given the prominence of this topic, we wonder if companies are finding it necessary to spend more to stay in place.

Advertising – companies have to communicate the benefits and differences of product offerings, old and new, to both consumers and retail partners

Emerging markets – characterized as a “once in a generation” opportunity, the potential represented by an expanding global middle class was consistently referenced

Productivity – doing more with less is necessary in a world where pricing is elusive, consumers are fickle, private label is growing and commodities are a wild card

M&A – not a presentation topic, but certainly a topic of cocktail conversation – who’s next? We don’t see the Heinz deal as a catalyst for wide spread M&A across staples. However, some names make sense as potential targets – HSH, for one. “Bolt-on” or smaller “tuck in” acquisitions were a consistent theme, but nothing transformative seemed on the horizon.

Cash – dividends are share repurchases seem to be the order of the day for the cash generative consumer staples sector.

Economic climate – The consensus seemed to indicate that the consumers’ health was improved versus the same time last year, but was still “fragile”. We saw more optimism for 2H ’13 and ‘ for ’14.

Where did our thinking change?

We won’t rehash the presentations, but as a quick summary:

CPB – less likely to want to short as core potentially stabilizes

KRFT – one of our favorite presentations, would be a buyer lower – upside to low $50s

HSH – again, one of our favorite presentations, more constructive

BG – doing more work here on the long side after an awful quarter, good long-term theme

Consumption Junction

Housing, labor markets, commodity deflation and a strengthening US dollar have kept us bullish on consumption over the last month. We expect consumption, which is a driver of growth in the economy, to continue to improve going forward as home prices rise while existing inventory falls and commodity prices fall lower.

Last week’s housing data was decidedly positive as existing home inventory declined 24.7% on a year-over-year basis to 1.74 million units and sits around 50% below the 2007 peak. The National Association of Realtors (NAR) reported that median home prices rose 12.2% year-over-year in January, marking the 13th consecutive month of acceleration. We’re of the belief that rising prices will continue to drive demand which should drive further pricing gains.

As for the US dollar, a stronger US dollar drives down commodity prices which drives consumption as more consumers head out to the grocery store and gas station and see a material change in price when shopping. The only remaining economic headwind that we still face is oil prices, which have shifted downward over the last two days but are up again this morning. When gas prices drop significantly and oil prices come down, we will really see consumption take off in a meaningful way.

Early Look

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